Managing the risk of spiralling costs in large projects

The National Audit Office (NAO) has published advice on how to manage the risk of spiralling costs in large projects, which are often high profile, complex and technically difficult. The NAO is responsible for scrutinising the government’s portfolio of major projects, which will cost more than £450 billion over their lifetime. While the advice is primarily focused around government initiatives, it contains valuable insight for any business thinking of committing to a major undertaking.

As the level of complexity and innovation required to deliver a project grows, so does the difficulty in providing an accurate estimate of the final cost and timescale. This can clash with pressure from financial backers to secure a concrete commitment on the required investment at the earliest possible opportunity, and is exacerbated by a tendency by project teams to be overly optimistic with their promises on delivery.

The NAO’s report recommends that risk managers be mindful of this innate optimism when deciding on the level of acceptable risk of cost increases. It says: “Beware of ‘entryism’. If a project is not realistically costed once it is in the programme it will be hard to cancel … Have a healthy scepticism about early cost estimates and an appreciation of the possible down side scenarios to address over-optimism and spare you some bad press.”

The NAO also advocates being clear about who is accountable for project decisions. If these responsibilities are confused or vague, it can lead to major decisions not being fully tested before they are implemented. Being clear about who is accountable within a project makes it more likely that commitments will be properly analysed and less likely that they will be based on overly optimistic or uncertain information.

Spotting the early warning signs

A number of factors can increase the likelihood of a project costing more than estimated, according to the report.  Too often, project teams fix on a preferred solution without thoroughly costing and exploring alternatives that may provide better value for money. Costs are also more likely to increase if the preferred solution involves unproven methodologies or where there is no pre-existing supply chain; projects that already have a precedent are easier to estimate and usually easier to complete.

The NAO suggests that major projects must be justifiable by their ‘hard’ benefits, which could include cost savings or increased revenues. Initiatives that are being justified by ‘softer’ benefits, such as employee morale or customer satisfaction, are inherently more difficult to measure and cannot necessarily be translated into tangible financial results.

Inevitably, there will be parties involved in projects which have a vested interest in their approval. The NAO warns that this can incentivise a certain level of optimism – or even deliberate underestimation – when it comes to costs. Early estimates will never be completely accurate and should always be presented as a range. If an early estimate is given as a single figure, it is likely that the team has not taken full account of the risk scenarios and their consequences.

Other red flags include underestimating the level of risk being taken on by the various stakeholders, especially with government projects, the NAO says. A request by the delivery team to release contingency or reserve funds early may indicate that a project is under financial pressure, as does  any recommendation to delay the project in order to stay within budget. The report cautions that risk managers should be sceptical of any suggestion that benefits are increasing along with costs, as this can simply be an attempt to maintain the appearance of success.

Proactively managing the risks

Key questions that risk managers should ask include whether the project is affordable both to the organisation and to service users upon completion, what the business impact would be at different levels of cost over-run and where the ‘red line’ at which a project becomes unviable lies. Check how much similar projects have cost previously, whether there’s an incentive for suppliers to underestimate their own costs, and the level of exposure to risk for the different parties.

The NAO recommends risk managers demand regular performance updates from project teams and assess them against the cost estimate to ensure they are delivering to time and budget. They should also ensure that critical risks are being properly monitored and managed and be clear about the impact of any delay on costs and long-term value. It advises: “Don’t wait for costs to overrun before you look for savings. Project teams should give as much time and attention to cost and driving out value as they do to time and quality.” The only way to measure a project’s performance is through consistent and transparent data, meaning teams’ reports need to be easy to reconcile both with the project’s objectives and with each other.

While the complexity of coordinating a large number of initiatives, resources, equipment and skills is a challenge, successful estimation and cost control of major projects increases the chances of achieving their anticipated benefits and ultimately ensuring value for money.